Cathay General Bancorp - 10-Q quarterly report FY

OR

For the transition period from ____________________________to _________________________________

Commission file number                                                        0-18630                                                                 

                                                             CATHAY GENERAL BANCORP                                                       

(Exact name of registrant as specified in its charter)

                      Delaware                                                                                         95-4274680                          

        (State of other jurisdiction of incorporation                                                     (I.R.S. Employer

                    or organization)                                                                                    Identification No.)

777 North Broadway, Los Angeles, California                                                             90012                               

(Address of principal executive offices)                                                                     (Zip Code)

Registrant's telephone number, including area code:     (213) 625-4700                                                                 

                                                                                                                                                                  &nbsp ;         

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common stock, $.01 par value, 49,918,722 sharesoutstanding as of October 31, 2004.

PART I - FINANCIAL INFORMATION *

Item 1. FINANCIAL STATEMENTS (Unaudited) *

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) *

Business *

Merger with GBC Bancorp and Related Acquisition Reserves *

Basis of Presentation *

Recent Accounting Pronouncements *

Financial Derivatives *

Stock Split and Increase in Dividend *

Earnings per Share *

Stock-Based Compensation *

Commitments and Contingencies *

Regulatory Matters *

Regulated Investment Company *

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS *

Critical Accounting Policies *

Income Statement Review *

Financial Condition Review *

Asset Quality Review *

Capital Resources *

Capital Adequacy Review *

Liquidity *

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK *

Market Risk *

Financial Derivatives *

Item 4. CONTROLS AND PROCEDURES *

PART II - OTHER INFORMATION *

Item 1. LEGAL PROCEEDINGS *

Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS *

Item 3. DEFAULTS UPON SENIOR SECURITIES *

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS *

Item 5. OTHER INFORMATION *

Item 6. EXHIBITS AND REPORTS ON FORM 8-K *

SIGNATURES *

Item 1. FINANCIAL STATEMENTS

CATHAY GENERAL BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)

CATHAY GENERAL BANCORP AND SUBSIDIARIES

(Unaudited)

Business

Cathay General Bancorp (the "Bancorp") is the holding company for Cathay Bank (the "Bank"), five limited partnerships investing in affordable housing investments in which the Bank is the sole limited partner, and GBC Venture Capital, Inc., (together the "Company" or "we", "us," or "our"). The Bancorp also owns 100% of the common stock of three statutory business trusts created for the purpose of issuing capital securities. The Bank was founded in 1962 and offers a wide range of financial services. The Bank now operates twenty branches in Southern California, nine branches in Northern California, one branch in Washington State, three branches in New York State, two branches in Massachusetts, and one branch in Houston, Texas, plus representative offices in Hong Kong and Shanghai, China. As part of its post-merger integration plans to efficiently serve its customers, the Bank closed six branches in April 2004 and closed three additional branches in Southern California in October 2004. In addition, the Bank's subsidiary, Cathay Investment Company maintains an office in Taiwan. The Bank is a commercial bank, servicing primarily individuals, professionals, and small to medium-sized businesses in the local markets in which its branches are located.

Merger with GBC Bancorp and Related Acquisition Reserves

As of the close of business on October 20, 2003, Cathay Bancorp, Inc. completed its merger with GBC Bancorp and its subsidiary, General Bank (the "GBC merger"), pursuant to the terms of the Agreement and Plan of Merger dated May 6, 2003. As a result of the merger, Cathay Bancorp, Inc. issued 6.75 million shares of its newly issued common stock, and paid $162.4 million in cash, including $7.2 million paid during 2004, for all of the issued and outstanding shares of GBC Bancorp common stock. In addition, Cathay Bancorp, Inc's name was changed to Cathay General Bancorp. The results of GBC Bancorp's operations have been included in the Company's consolidated financial statements since October 20, 2003. The return on assets and return on equity after the merger with GBC Bancorp are lower than in previous periods, due in part to the increases in assets and stockholders' equity as a result of the GBC merger.

Reserves for estimated lease termination costs of $1.3 million and severance and contract termination costs of $1.3 million were established as purchase price adjustments for the October 20, 2003, merger with GBC Bancorp. Through September 30, 2004, approximately $0.8 million of these costs have been incurred and paid. During 2004, goodwill was decreased due to a decrease of $1.1 million of income taxes payable upon finalization of GBC Bancorp's tax return for 2003, increased by $0.4 million as a result of an adjustment to the premium assigned to fixed rate loans to reflect estimated prepayments and increased $0.3 million as a result of the increase in the reserve for estimated lease termination costs as a result of more precisely determining the General Bank branches which were closed and several other smaller adjustments. The net impact of these adjustments was a reduction in goodwill of $0.7 million.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP")for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. Certain reclassifications have been made to the prior year's financial statements to conform to the current year's presentation. For further information, refer to the audited consolidated financial statements and footnotes included in the Company's annual report on Form 10-K for the year ended December 31, 2003.

The preparation of the consolidated financial statements in accordance with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The most significant estimate subject to change relates to the allowance for loan losses.

Recent Accounting Pronouncements

Financial Derivatives

The Company enters into financial derivatives in order to mitigate exposure to interest rate risks related to its interest-earning assets and interest-bearing liabilities. The Company recognizes all derivatives on the balance sheet at fair value. Fair value is based on dealer quotes or quoted prices from instruments with similar characteristics. For derivatives designated as cash flow hedges, changes in fair value are recognized in other comprehensive income until the hedged item is recognized in earnings. For derivatives designated as fair value hedges, changes in the fair value of the derivatives are reflected in current earnings, together with changes in the fair value of the related hedged item if there is a highly effective correlation between changes in the fair value of the interest rate swaps and changes in the fair value of the underlying asset or liability that is intended to be hedged. If there is not a highly effective correlation between changes in the fair value of the interest rate swaps and changes in the fair value of the underlying asset or liability that is intended to be hedged, then only the changes in the fair value of the interest rate swaps are reflected in the Company's financial statements.

On March 21, 2000, the Company entered into an interest rate swap agreement with a major financial institution in the notional amount of $20.0 million for a period of five years. The interest rate swap was for the purpose of hedging the cash flows from a portion of our floating rate loans against declining interest rates. The purpose of the hedge is to provide a measure of stability in the future cash receipts from such loans over the term of the swap agreement, which at September 30, 2004, had a remaining term of approximately two quarters. At September 30, 2004, the fair value of the interest rate swap was $0.5 million, exclusive of accrued interest. Amounts to be paid or received on the interest rate swap are reclassified into earnings upon the receipt of interest payments in the underlying hedged loans, including amounts totaling $0.2 million that were reclassified into earnings during the quarter ended September 30, 2004. The estimated net amount of the existing gains within accumulated other comprehensive income that are expected to reclassify into earnings within the next six months is approximately $0.4 million.

In 2004, the Company entered into interest rate swaps with notional amounts of $85.4 million for five years to mitigate risks associated with changes to the fair value of a like amount of fixed rate certificates of deposit (CDs). The five year interest rate swaps will terminate in 2009 and can be terminated after two years at the election of the counterparty. For the first two years of the swaps, the Company will receive interest at a weighted average fixed rate of 3.15% and will pay interest at a rate of LIBOR less 12.5 basis points. If the swaps are not terminated in 2006, then the Company will receive interest at a weighted average fixed rate of 6.0% and will pay interest at a rate of LIBOR less 12.5 basis points for the last three years of the swap term. The five year CDs will mature in 2009 and can be terminated after two years at the election of the Bank. For the first two years of the CDs, the Bank will pay interest of 3.03%. If it does not call the CDs, then the Bank will pay interest of 5.86% for the last three years. As of September 30, 2004, the fair value of these interest rate swaps was an unrealized gain of $342,000 and the fair value of the CDs hedged by these swaps was an unrealized loss of $317,000. These amounts have been recorded in income for the third quarter.

During the third quarter of 2004, the Company entered into $25.0 million notional amount of three year interest rate swaps maturing in 2007 which can be terminated in 2005 at the election of the counterparty. Although these swaps were entered into as a hedge against a like amount of step up CDs, there was insufficient correlation between the changes in the fair value of the interest rate swaps versus the changes in the fair value of the step up CDs to permit hedge accounting treatment. At September 30, 2004, the fair value of the $25.0 million of interest rate swaps of $38,000 was recorded as other income.

During the third quarter and the first nine months of 2004, the $110.4 million in notional amount of interest rate swaps added $341,000 and $358,000, respectively, to net interest income. The estimated net interest income expected within the next twelve months from these interest rate swaps is approximately $0.9 million.

Stock Split and Increase in Dividend

On August 19, 2004, the Company's Board of Directors approved a two-for-one stock split of the Company's common stock, in the form of a 100% stock dividend, paid on September 28, 2004, to stockholders of record on September 13, 2004. Share and per share numbers for all periods presented reflect the two-for-one stock split that became effective on September 28, 2004. On October 1, 2004, the Company's Board of Directors approved a 29% increase in the common stock dividend from $0.07 to $0.09 per share payable on October 22, 2004, to stockholders of record on October 13, 2004.

Earnings per Share

Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock that then shared in earnings.

For the three months and nine months ended September 30, 2004, options to purchase an additional 2.5 million shares of common stock were outstanding, but were not included in the computation of diluted earnings per share because their inclusion would have had an antidilutive effect. For the three months ended September 30, 2003, all options to purchase shares of common stock were included in the computation of diluted earnings share. For the nine months ended September 30, 2003, 0.2 million shares of common stock were outstanding, but were not included in the computation of diluted earnings per share because their inclusion would have had an antidilutive effect.

The following table sets forth basic and diluted earnings per share calculations:

Stock-Based Compensation

Prior to 2003, the Company used the intrinsic-value method to account for stock-based compensation. Accordingly, no expense was recorded in periods prior to 2003. In 2003, the Company adopted prospectively the fair value recognition provisions of Financial Accounting Standards Board ("FASB") Statement No. 123, "Accounting for Stock-Based Compensation," as amended by FASB Statement No. 148, "Accounting for Stock-Based Compensation - - Transition and Disclosure, an Amendment of FASB Statement No. 123," and began recognizing the expense associated with stock options granted starting in 2003 using the fair value method, which resulted in charges to salaries and employee benefits for the third quarters of 2004 and 2003 of $798,000 and $97,000, respectively. For the nine months ended September 2004 and 2003, the compensation expense associated with stock options granted was $2.3 million and $291,000, respectively. Stock-based compensation expense for stock options is calculated based on the fair value of the award at the grant date, and is recognized as an expense over the vesting period of the grant. The Company uses the Black-Scholes option pricing model to estimate the value of granted options. This model takes into account the option exercise price, the expected life, the current price of the underlying stock, the expected volatility of the Company's stock, expected dividends on the stock, and a risk-free interest rate. Since compensation cost is measured at the grant date, the only variable whose change would impact expected compensation expense recognized in future periods for these grants is actual forfeitures.

Under SFAS No.123, the weighted average per share fair value of the options granted during the nine months of 2004 and the full year 2003 was $6.80 and $5.56, respectively, on the date of grant. Fair value under SFAS No.123 is determined using the Black-Scholes option pricing model with the following assumptions:

If the compensation cost for all awards granted under the Company's stock option plan had been determined using the fair value method of SFAS No. 123, the Company's net income and earnings per share for the three months and the nine months ended September 30, 2004, and 2003, would have been reduced to the pro forma amounts indicated in the table below.

Commitments and Contingencies

In the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of loans, or through commercial or standby letters of credit, and financial guarantees. Those instruments represent varying degrees of exposure to risk in excess of the amounts included in the accompanying unaudited condensed consolidated statements of financial condition. The contractual or notional amount of these instruments indicates a level of activity associated with a particular class of financial instrument and is not a reflection of the level of expected losses, if any.

The Company's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the commitment agreement. These commitments generally have fixed expiration dates and the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management's credit evaluation of the borrowers. Letters of credit, including standby letters of credit and bill of lading guarantees, are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing these types of instruments is essentially the same as that involved in making loans to customers.

Regulatory Matters

Following a regular examination by the Federal Deposit Insurance Corporation (the "FDIC"), the Bank's Board of Directors, on June 17, 2004, approved and signed a memorandum of understanding ("MOU") with the FDIC in connection with certain deficiencies identified by the FDIC relating to the Bank's compliance with certain provisions of the Bank Secrecy Act (the "BSA"). Under the terms of the MOU, the Bank must comply in all material respects with the BSA within 90 days from the MOU's effective date, July 18, 2004. The MOU requires in part that the Bank perform an analysis of its BSA risk profile and implement a written action plan designed to ensure compliance with the BSA. Such plan will include revisions of the Bank's policies and procedures, enhancements of the Bank's internal controls for BSA compliance, independent compliance testing, dedicated compliance staff, and regular employee training. The Bank is currently in compliance in all material respects with the terms of the MOU.

The MOU is expected to result in additional BSA compliance expenses for the Bank, although these expenses are not anticipated to have a material financial impact on the Bancorp. It may also have the effect of limiting or delaying the Bank's and the Bancorp's ability to obtain regulatory approval for certain expansionary activities.

Regulated Investment Company

As previously disclosed, in the fourth quarter of 2003, the California Franchise Tax Board (FTB) announced its intent to list certain transactions that in its view constitute potentially abusive tax shelters. Included in the transactions subject to this listing were transactions utilizing regulated investment companies (RICs) and real estate investment trusts (REITs). As part of the notification indicating the listed transactions, the FTB also indicated its position that it intends to disallow tax benefits associated with these transactions. As also previously disclosed, in December 2002, the Company decided to deregister its regulated investment company and, in February 2003, the Company completed such deregistration. The Company had created the regulated investment company for the purpose of raising capital.

The Company believes that the tax benefits recorded in the three prior years with respect to its regulated investment company were appropriate and fully defensible under California law in effect at the time the tax benefits were recorded. The Company had relied on the existing California tax law related to regulated investment companies and on an outside tax opinion in creating this subsidiary. While the Company continues to believe that the tax benefits realized in previous years were appropriate, the Company deemed it prudent to participate in the Voluntary Compliance Initiative - Option 2, requiring payment of all California taxes and interest on these disputed 2000 through 2002 tax benefits, and permitting the Company to claim a refund for these years while avoiding certain potential penalties. The Company retains potential exposure for assertion of an accuracy related penalty should the FTB prevail in its position, in addition to the risk of not being successful in its refund claims for taxes and interest. As of September 30, 2004, the Company reflected a $12.3 million net state tax receivable for the years 2000, 2001, and 2002 after giving effect to reserves for loss contingencies on the refund claims, or an equivalent of $8.0 million after giving effect to Federal tax benefits. Although the Company believes its tax deductions related to the regulated investment company were appropriate and fully defensible, there can be no assurance of the outcome of its refund claims, and an adverse outcome on the refund claims could result in a loss of all or a portion of the $8.0 million net state tax receivable after giving effect to Federal tax benefits.

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is given based on the assumption that the reader has access to and has read the Annual Report on Form 10-K for the year ended December 31, 2003, of Cathay General Bancorp ("Bancorp") and its wholly-owned subsidiary Cathay Bank (the "Bank" and together the "Company" or "we", "us," or "our").

The statements in this report include forward-looking statements regarding management's beliefs, projections, and assumptions concerning future results and events. These forward-looking statements may, but do not necessarily, include words such as "believes," "expects," "anticipates," "intends," "plans," "estimates," "may," "will," "should," "could," "predicts," "potential," "continue" or similar expressions. Forward-looking statements are not guarantees. They involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, adverse developments, or conditions related to or arising from:

• the Company's ability to integrate its operations after its recent merger with GBC Bancorp and to realize the benefits of that merger;
• demographic changes;
• fluctuations in interest rates;
• inflation;
• competition;
• war and terrorism;
• general economic or business conditions in California and other regions where Cathay Bank has operations such as the impact of the California budget deficit;
• changes in business strategy, including the formation of a real estate investment trust (REIT) and the deregistration of its registered investment company (RIC);
• and legislative and regulatory developments such as the potential effects of recently enacted California tax legislation and the subsequent Franchise Tax Board announcement on December 31, 2003 regarding the taxation of REITs and RICs; and of the memorandum of understanding between Cathay Bank and the Federal Deposit Insurance Corporation relating to the Bank's compliance with certain provisions of the Bank Secrecy Act.

These and other factors are further described in Cathay General Bancorp's Annual Report on Form 10-K for the year ended December 31, 2003, its reports and registration statements filed (including those filed by GBC Bancorp prior to the merger) with the Securities and Exchange Commission ("SEC") and other filings it makes in the future with the SEC from time to time. Cathay General Bancorp has no intention and undertakes no obligation to update any forward-looking statement or to publicly announce the results of any revision of any forward-looking statement to reflect future developments or events.

Cathay General Bancorp's filings with the SEC are available to the public from commercial document retrieval services and at the website maintained by the SEC at htpp://www.sec.gov, or by requests directed to Cathay General Bancorp, 777 North Broadway, Los Angeles, California 90012, Attn: Investor Relations (213) 625-4749.

Critical Accounting Policies

The discussion and analysis of our consolidated financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Accounting for the allowance for loan losses involves significant judgments and assumptions by management, which have a material impact on the carrying value of net loans; management considers this accounting policy to be a critical accounting policy. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances as described under the heading "Allowance for Loan Losses."

Accounting for the merger with GBC Bancorp involves significant judgments and assumptions by management, which have a material impact on the carrying value of fixed rate loans and borrowings and the determination of core deposit intangible assets and goodwill. The judgments and assumptions used by management are described herein and in Note 2 to the Consolidated Financial Statements in the Company's annual report on Form 10-K for the year ended December 31, 2003.

THIRD QUARTER HIGHLIGHTS:

• T hird quarter earnings increased $10.2 million, or 78%, compared to the same quarter a year ago.
• Fully diluted earnings per share reached $0.46 and increased 28% compared to the same quarter a year ago.
• Gross loans increased by $106.9 million, or 3%, primarily in commercial mortgage loans, from June 30, 2004.
• Deposits increased by $33.1 million, or 1% from June 30, 2004.
• Return on average stockholders' equity was 14.08% and return on average assets was 1.60% for the quarter ended September 30, 2004.
• Nonaccrual loans decreased $8.5 million from $26.7 million at June 30, 2004, to $18.2 million at September 30, 2004.
• Efficiency ratio of 36.85% for the third quarter of 2004.
• The Board of Directors approved a two-for-one stock split of the Company's common stock, in the form of a 100% stock dividend and on October 1 approved a 29% increase in the quarterly cash dividend from $.07 to $.09 a share to be paid on October 22, 2004.

Income Statement Review

Net Income

Net income for the third quarter of 2004 was $23.2 million or $0.46 per diluted share, a 78.0% increase in net income compared with net income of $13.0 million or $0.36 per diluted share for the same quarter a year ago. Return on average stockholders' equity was 14.08% and return on average assets was 1.60% for the third quarter of 2004 compared with a return on average stockholders' equity of 16.55% and a return on average assets of 1.66% for the three months ended September 30, 2003.

FINANCIAL PERFORMANCE

Net Interest Income Before Provision for Loan Losses

Net interest income before provision for loan losses increased to $54.8 million during the third quarter of 2004, or 98.9% higher than the $27.6 million during the same quarter a year ago. The increase was due primarily to the merger with GBC Bancorp and strong growth in loans.

The net interest margin, on a fully taxable-equivalent basis, increased 11 basis points from 4.02% during the second quarter 2004 to 4.13% for the third quarter 2004. The net interest margin increased from 3.80% in the third quarter of 2003 to 4.13% in the third quarter of 2004, primarily as a result of increases in the prime rate, higher yields on investment securities, and interest collected from payoffs of several nonaccrual loans.

For the third quarter of 2004, the interest rate earned on our average interest-earning assets was 5.25% on a fully taxable-equivalent basis, and our cost of funds on average interest-bearing liabilities equaled 1.37%. In comparison, for the third quarter of 2003, the interest rate earned on our average interest-earning assets was 5.02% and our cost of funds on average interest-bearing liabilities equaled 1.47%.

Average daily balances, together with the total dollar amounts, on a taxable-equivalent basis, of interest income and interest expense, and the weighted-average interest rate, the net interest spread and the net interest margin were as follows:

Provision for Loan Losses

The provision for loan losses was zero for both the second and third quarters of 2004 compared to $1.7 million for the third quarter of 2003. The provision for loan losses represents the charge against current earnings that is determined by management, through a credit review process, as the amount needed to maintain an allowance for loan losses that management believes should be sufficient to absorb loan losses inherent in the Company's loan portfolio. Total chargeoffs and recoveries for the third quarter of 2004 were $2.4 million and $2.5 million, respectively, compared to total chargeoffs and recoveries of $15,000 and $61,000, respectively, for the third quarter of 2003. Total net recoveries for the nine months in 2004 were $233,000 compared to net charge-offs of $124,000 for the nine months in 2003.

Non-Interest Income

Non-interest income, which includes revenues from service charges on deposit accounts, letters of credit commissions, securities gains (losses), gains (losses) from loan sales, wire transfer fees, and other sources of fee income, was $4.7 million for the third quarters of both 2004 and 2003.

For the third quarter of 2004, the Company recorded net securities losses of $0.3 million compared to $1.7 million of net gains for the same quarter in 2003.

Letters of credit commissions increased $579,000, or 106.8%, from $542,000 in the third quarter of 2003 to $1.1 million in the third quarter of 2004. Comparing the third quarter of 2004 to the third quarter of 2003, depository service fees increased $542,000, or 39.1% and other operating income increased $822,000, or 73.6%. These increases were due primarily to the merger with GBC Bancorp.

Non-Interest Expense

Non-interest expense increased $10.8 million to $22.0 million in the third quarter of 2004 primarily due to the merger with GBC Bancorp. The efficiency ratio was 36.85% for the third quarter 2004 compared to 34.42% in the year ago quarter. Salaries and employee benefits increased $6.0 million or 91.8% from $6.5 million in the third quarter of 2003 to $12.5 million in the third quarter of 2004 due to the merger with GBC Bancorp and a $798,000 increase in compensation expense due to the amortization of compensation expense associated with stock options granted after the third quarter of 2003. Occupancy expense increased by $1.0 million or 92.1%, from $1.1 million in the third quarter of 2003 to $2.1 million in the third quarter of 2004, due primarily to the merger with GBC Bancorp. Computer and equipment expense increased $646,000 or 84.3% from $766,000 in the third quarter of 2003 to $1.4 million in the third quarter of 2004 due to the merger with GBC Bancorp. Professional services expense increased $822,000 or 91.2% from $901,000 in the third quarter of 2003 to $1.7 million in the third quarter of 2004 due to higher legal, consulting, and other professional expenses primarily as a result of the merger with GBC Bancorp. Amortization of core deposit intangibles increased by $1.3 million due to the merger with GBC Bancorp. Other operating expenses increased $690,000 or 109.5% due to the merger with GBC Bancorp.

Income Taxes

The effective tax rates for the third quarter of 2004 and 2003 were 38.3% and 33.3%, respectively, compared to 36.7% for the full year 2003. The effective tax rate for the third quarter of 2004 of 38.3% increased from the full year 2003 effective tax rate of 36.7% because the tax benefits from the Company's investments in affordable housing and other tax-exempt investments comprise a smaller percentage of pretax income in 2004 compared to 2003. Quarterly comparisons with the first three quarters of 2003 are impacted by the real estate investment trust ("REIT") state tax benefits which reduced income tax expense in the first three quarters of 2003, and increased income tax expense in the fourth quarter of 2003, when the previously recorded benefit was reversed.

As previously disclosed, on December 31, 2003, the California Franchise Tax Board (FTB) announced its intent to list certain transactions that in its view constitute potentially abusive tax shelters. Included in the transactions subject to this listing were transactions utilizing regulated investment companies (RICs) and real estate investment trusts (REITs). As part of the notification indicating the listed transactions, the FTB also indicated its position that it intends to disallow tax benefits associated with these transactions. While the Company continues to believe that the tax benefits recorded in three prior years with respect to its regulated investment company were appropriate and fully defensible under California law, the Company has deemed it prudent to participate in Voluntary Compliance Initiative - Option 2, requiring payment of all California taxes and interest on these disputed 2000 through 2002 tax benefits, and permitting the Company to claim a refund for these years while avoiding certain potential penalties. The Company retains potential exposure for assertion of an accuracy-related penalty should the FTB prevail in its position in addition to the risk of not being successful in its refund claims. As of September 30, 2004, the Company reflected a $12.3 million net state tax receivable for the years 2000, 2001, and 2002 after giving effect to reserves for loss contingencies on the refund claims, or an equivalent of $8.0 million after giving effect to Federal tax benefits. Although the Company believes its tax deductions related to the regulated investment company were appropriate and fully defensible, there can be no assurance of the outcome of its refund claims, and an adverse outcome on the refund claims could result in a loss of all or a portion of the $8.0 million net state tax receivable after giving effect to Federal tax benefits.

Year-to-Date Income Statement Review

Net income was $65.2 million or $1.30 per diluted share for the nine months ended September 30, 2004, an increase of 68.1% in net income over the $38.8 million or $1.07 per diluted share for the same period a year ago. The net interest margin for the nine months ended September 30, 2004, increased 13 basis points to 4.07% compared to 3.94% in the same period a year ago.

The average daily balances, together with the total dollar amounts, on a taxable-equivalent basis, of interest income and interest expense, and the weighted-average interest rates, the net interest spread and the net interest margins were as follows:

Return on average stockholders' equity was 13.56% and return on average assets was 1.53% for the nine months ended September 30, 2004, compared to a return on average stockholders' equity of 17.10% and a return on average assets of 1.75% for the nine months ended September 30, 2003. The efficiency ratio for the nine months ended September 30, 2004, was 39.08% compared to 35.20% during the same period a year ago.

Financial Condition Review

Assets

Total assets increased by $351.1 million to $5.9 billion at September 30, 2004, up 6.3% from year-end 2003 of $5.5 billion. The increase in total assets was due primarily to increases in loans and investment securities.

Securities

Total securities were $1.80 billion or 30.5% of total assets at September 30, 2004 compared with $1.71 billion or 30.8% of total assets at December 31, 2003.

The net unrealized gain on securities available-for-sale, which represents the difference between fair value and amortized cost, decreased to $7.8 million at September 30, 2004, compared with a net unrealized gain of $15.2 million at year-end 2003 primarily as a result of increases in interest rates and the maturity or sales of higher yielding securities. Net unrealized gains on the securities available-for-sale are included in accumulated other comprehensive income or loss, net of tax.

The average taxable-equivalent yield on taxable investment securities increased 48 basis points to 4.30% for the quarter ended September 30, 2004, compared with 3.82% during the same quarter a year ago, due to purchases of securities at higher interest rates during 2004 and significant amortization of securities premiums in the third quarter of 2003 as a result of high prepayments on mortgage backed securities.

The following tables summarize the composition, amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available-for-sale, as of September 30, 2004, and December 31, 2003:

The Company has the ability and intent to hold the impaired securities included in the table above for a period of time sufficient for a recovery of cost. The impaired securities represent 33.2% of the fair value of the Company's total investment securities. Unrealized losses on these securities generally resulted from changes in interest rates from the date that these securities were purchased. All of these securities are investment grade.

At September 30, 2004, equity securities included $20.3 million of preferred stock issued by the Federal National Mortgage Association and Federal Home Loan Mortgage Corporation. These issues of preferred stock are tied to various short term indexes ranging from the three-month LIBOR interest rate to the two year U. S. treasury rate. These securities have AA- credit ratings from the securities rating agencies and are callable by the issuer at par. At September 30, 2004, the unrealized loss on these securities totaled $4.8 million compared to $4.3 million at December 31, 2003, as a result of an increase in the spreads compared to U S Treasury securities for these securities. It is expected that these investments will increase in value as short term interest rates rise toward their long term average level if spreads do not increase.

In March 2004, the FASB issued Emerging Issues Task Force Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments". This EITF describes a model involving three steps: (1) determine whether an investment is impaired, (2) determine whether the impairment is other-than-temporary, and (3) recognize the impairment loss in earnings. The EITF also requires several additional disclosures for cost-method investments. In September, the FASB approved the deferral of the effective date for EITF No. 03-1 until such time as new guidance is issued and comes into effect.

At September 30, 2004, management believes the impairments detailed in the table above are temporary and, accordingly, no impairment loss has been recognized in the Company's unaudited condensed consolidated statement of income.

The following table summarizes the scheduled maturities by security type of securities available-for-sale as of September 30, 2004:

Loans

Gross loans at September 30, 2004, were $3.64 billion compared with gross loans at year-end 2003 of $3.31 billion. Gross loan growth during the third quarter equaled $106.9 million, an increase of 3.0% from second quarter 2004, reflecting primarily increases in commercial mortgage loans.

Commercial mortgage loans increased $355.9 million or 20.7% to $2.07 billion at September 30, 2004, compared to $1.72 billion at year-end 2003. At September 30, 2004, this portfolio represented approximately 58.1% of the Bank's net loans compared to 53.1% at year-end 2003. The increases in commercial mortgage loans were partially offset by decreases in commercial loans totaling $15.1 million and decreases in construction loans totaling $60.4 million.

The following table sets forth the classification of loans by type, mix, and percentage change as of the dates indicated:

Asset Quality Review

Non-performing Assets

Non-performing assets ("NPAs") to gross loans plus other real estate owned decreased to 0.80% at September 30, 2004, from 1.19% at December 31, 2003, and increased from 0.24% at September 30, 2003. More than two-thirds of the $11.0 million in loans past due 90 days or more and still accruing interest are secured by real estate. Total non-performing assets decreased to $29.2 million at September 30, 2004, compared with $39.3 million at December 31, 2003, and $4.9 million at September 30, 2003. Non-performing assets include accruing loans past due 90 days or more, non-accrual loans, and other real estate owned.

The following table sets forth the breakdown of non-performing assets by categories as of the dates indicated:

Non-accrual Loans

Non-accrual loans of $18.2 million at September 30, 2004, consisted mainly of $7.4 million in real estate loans and $10.8 million in commercial loans. The following table presents non-accrual loans by type of collateral securing the loans, as of the dates indicated:

The following table presents non-accrual loans by type of businesses the borrowers are engaged in, as of the dates indicated:

Troubled Debt Restructurings

A troubled debt restructuring ("TDR") is a formal restructure of a loan when the lender, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower. The concessions may be granted in various forms, including reduction in the stated interest rate, reduction in the loan balance or accrued interest, or extension of the maturity date.

At September 30, 2004, troubled debt restructurings decreased to $1.0 million compared to $5.8 million at December 31, 2003, mainly due to loan payoffs.

Subsequent to September 30, 2004, in addition to loans disclosed above as past due, nonaccrual, or restructured, management also identified a credit facility consisting of a $9.5 million loan and a $0.4 million remaining commitment as to which the borrower's future ability to comply with the present loan repayment terms appears to be uncertain. This credit facility was originated by the former New York City loan production office of General Bank and its collateral includes accounts receivable, inventory, and residential real estate.

Impaired Loans

A loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement based on current circumstances and events.

We evaluate all classified and restructured loans for impairment. The classified loans are stratified by size, and loans less than our defined selection criteria are treated as a homogenous portfolio. If loans meeting the defined criteria are not collateral dependent, we measure the impairment based on the present value of the expected future cash flows discounted at the loan's effective interest rate. If loans meeting the defined criteria are collateral dependent, we measure the impairment by using the loan's observable market price or the fair value of the collateral. If the measurement of the impaired loan is less than the recorded amount of the loan, we then recognize impairment by creating or adjusting an existing valuation allowance with a corresponding charge to the provision for loan losses.

We identified impaired loans with a recorded investment of $18.2 million at September 30, 2004, compared with $40.8 million at year-end 2003. The decrease in impaired loans during the first nine months of 2004 resulted from payoffs and improvements in credit quality of loans previously considered impaired. The following tables present a breakdown of impaired loans and the related allowances as of the dates indicated:

Loan Concentration

There were no loan concentrations to multiple borrowers in similar activities which exceeded 10% of total loans as of September 30, 2004, or December 31, 2003.

Allowance for Loan Losses

The Bank's management is committed to managing the risk in its loan portfolio by maintaining the allowance for loan losses at a level that is considered to be equal to the estimated and known risks in the loan portfolio. With a risk management objective, the Bank's management has an established monitoring system that is designed to identify impaired and problem loans and permit periodic evaluation of impairment and the adequacy level of the allowance for loan losses in a timely manner. The nature of the process by which the Bank determines the appropriate allowance for loan losses requires the exercise of considerable judgment. The allowance for loan losses is increased by charges to the provision for loan losses. Identified credit exposures that are determined to be uncollectible are charged against the allowance for loan losses. Recoveries of previously charged off amounts, if any, are credited to the allowance for loan losses.

The allowance for loan losses amounted to $66.0 million at September 30, 2004, and represented the amount needed to maintain an allowance that we believe should be sufficient to absorb loan losses inherent in the Company's loan portfolio. The allowance for loan losses represented 1.81% of period-end gross loans and 226% of non-performing loans at September 30, 2004. The comparable ratios were 1.99% of year-end 2003 gross loans and 169% of non-performing loans at December 31, 2003. Total chargeoffs and recoveries for the third quarter of 2004 were $2.4 million and $2.5 million, respectively, compared to total chargeoffs and recoveries of $15,000 and $61,000, respectively, for the third quarter of 2003. The following table sets forth information relating to the allowance for loan losses for the periods indicated:

Our allowance for loan losses consists of the following:

1. Specific allowance: For impaired loans, we provide specific allowances based on an evaluation of impairment, and for each criticized loan, we allocate a portion of the general allowance to each loan based on a loss percentage assigned. The percentage assigned depends on a number of factors including loan classification, the current financial condition of the borrowers and guarantors, the prevailing value of the underlying collateral, charge-off history, management's knowledge of the portfolio, and general economic conditions.
2. General allowance: The unclassified portfolio is segmented on a group basis. Segmentation is determined by loan type and by identifying risk characteristics that are common to the groups of loans. The allowance is provided to each segmented group based on the group's historical loan loss experience, trends in delinquencies and non-accrual loans, and other significant factors, such as national and local economy, trends and conditions, strength of management and loan staff, underwriting standards, and the concentration of credit.

To determine the adequacy of the allowance in each of these two components, the Bank employs two primary methodologies, the classification process methodology and the individual loan review analysis methodology. These methodologies support the basis for determining allocations between the various loan categories and the overall adequacy of the Bank's allowance to provide for probable loss in the loan portfolio.

With these above methodologies, the specific allowance is for those loans internally classified and risk graded as Special Mention, Substandard, Doubtful, or Loss. Additionally, the Bank's management allocates a specific allowance for "Impaired Credits," in accordance with SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." The level of the general allowance is established to provide coverage for management's estimate of the probable losses in the loan portfolio by various loan segments not covered by the specific allowance.

The table set forth below reflects management's allocation of the allowance for loan losses by loan category and the ratio of each loan category to the total loans as of the dates indicated:

The allowance allocated to commercial loans increased to $36.7 million at September 30, 2004, from $34.3 million at December 31, 2003, due to an increase in the allowance allocated to the Continental Airlines lease as a result of continued weakness in the airline industry and increases in oil prices and an increase to the reserve factor for pass rated commercial loans to reflect the combined historical loss experience of Cathay Bank and General Bank. Commercial loans comprised 59.1% of nonaccrual loans, and 40.4% of loans over 90 days still on accrual status at September 30, 2004.

Because the credit quality of the residential mortgage loan portfolio has remained steady during the third quarter of 2004, management has maintained the allocated allowance for this segment at $1.1 million.

The allowance allocated to commercial mortgage loans increased from $17.5 million at December 31, 2003, to $24.3 million at September 30, 2004, due to the growth in the size of the commercial mortgage loan portfolio. Commercial mortgage loans comprised 22.1% of nonaccrual loans and 11.5% of loans over 90 days still on accrual status, respectively, at September 30, 2004.

The allowance allocated to construction loans has decreased from $12.9 million or 3.6% of December 31, 2003 construction loans, to $3.8 million or 1.3% of September 30, 2004, construction loans. The decrease in the allowance allocated to construction loans was due to the decline in construction loans during the nine months of 2004, including the payoff and sale of a number of construction loans with credit weaknesses. At September 30, 2004, $3.3 million in construction loans were on nonaccrual status.

Allowances for other risks of probable loan losses equaled $4.8 million as of September 30, 2004, compared to $3.3 million as of December 31, 2003. The components of the other risks that have the potential to affect the Bank's portfolio are comprised of two basic elements. The Bank has set aside funds to cover the risk factors for general economic conditions such as the continued slow recovery from the last recession and the record high oil prices. The other component of other portfolio risk is the potential errors in loan classification and review methodologies, especially the integration of General Bank's loan grading and reserving methodology with that of Cathay Bank. Based on these two components of other risks, management believes that the allowance for other risks of probable loan losses is appropriate.The allowance for other risks of probable loan losses is allocated in the table above by type of loan.

Other Assets

On March 18, 2004, the Company signed a stock purchase agreement with Broadway Financial Corporation (Broadway) providing for the purchase by the Company of shares of Broadway common stock at a price of $13.50 per share. On June 11, 2004, the Company purchased 70,000 shares (a 4.9% interest) of Broadway's common stock for $945,000.

Deposits

Total deposits increased $113.3 million, or 2.6%, from December 31, 2003, and $33.1 million, or 0.7%, from June 30, 2004. Non-interest-bearing checking accounts, interest-bearing checking accounts, and savings accounts comprised 43.3% of total deposits at September 30, 2004, time deposit accounts of less than $100,000 comprised 11.8% of total deposits, while the remaining 44.9% was comprised of time deposit accounts of $100,000 or more.

The following table displays the deposit mix as of the dates indicated:

Borrowings

Total advances from the Federal Home Loan Bank of San Francisco increased by $170.8 million to $429.1 million at September 30, 2004, compared with $258.3 million at year-end 2003. On January 28, 2004, Bancorp repaid in full the $20 million term loan borrowed from another financial institution.

Other Liabilities

Other liabilities increased to $72.1 million at September 30, 2004, from $56.1 million at December 31, 2003, due primarily to the pending settlement of securities purchased of $16.5 million.

Capital Resources

Stockholders' equity of $677.3 million at September 30, 2004, increased by $58.0 million, or 9.4%, compared to $619.3 million at December 31, 2003. The following table summarizes the increase in stockholders' equity:

In April 2001, the Board of Directors approved a stock repurchase program of up to $15 million of the Company's common stock. Cumulatively through September 30, 2004, the Company has repurchased 639,820 shares of our common stock for $8.8 million. No shares have been repurchased since the third quarter of 2003.

The Company declared cash dividends of 7 cents per share in January 2004 on 49,610,926 shares outstanding, in April 2004 on 49,718,808 shares outstanding, and in July 2004 on 49,779,354 shares outstanding. On October 1, 2004, the Company declared a cash dividend of 9 cents per share on 49,850,804 shares outstanding. Total cash dividends paid in 2004, including the $4.5 million paid in October, amounted to $14.9 million. The dividend information contained in this paragraph reflects the two-for-one stock split that became effective September 28, 2004.

Under the Equity Incentive Plan adopted by the Board of Directors in 1998, the Company granted options to purchase 676,200 shares of common stock with an exercise price of $28.70 per share to eligible officers and directors on February 19, 2004. In addition, in the second quarter of 2004, the Company granted an additional 65,000 shares with weighted average exercise price of $32.37 per share. There were no options granted in the third quarter of 2004.

Capital Adequacy Review

Management seeks to maintain the Company's capital at a level sufficient to support future growth, protect depositors and stockholders, and comply with various regulatory requirements.

Both the Bancorp's and the Bank's regulatory capital continued to well exceed the regulatory minimum requirements as of September 30, 2004. In addition, the capital ratios of the Bank place it in the "well capitalized" category, which is defined as institutions with total risk-based ratio equal to or greater than 10.0%, Tier 1 risk-based capital ratio equal to or greater than 6.0%, and Tier 1 leverage capital ratio equal to or greater than 5.0%.

The following table presents the Bancorp's capital and leverage ratios as of September 30, 2004, and December 31, 2003:

The following table presents the Bank's capital and leverage ratios as of September 30, 2004, and December 31, 2003:

Liquidity

Liquidity is our ability to maintain sufficient cash flow to meet maturing financial obligations and customer credit needs, and to take advantage of investment opportunities as they are presented in the marketplace. Our principal sources of liquidity are growth in deposits, proceeds from the maturity or sale of securities and other financial instruments, repayments from securities and loans, federal funds purchased, securities sold under agreements to repurchase, and advances from the Federal Home Loan Bank ("FHLB"). At September 30, 2004, our liquidity ratio (defined as net cash, short-term and marketable securities to net deposits and short-term liabilities) decreased slightly to 28.8% compared to 32.9% at year-end 2003.

To supplement its liquidity needs, the Bank maintains a total credit line of $101.5 million for federal funds with three correspondent banks, and master agreements with five brokerage firms whereby up to $300.0 million would be available through the sale of securities subject to repurchase. The Bank is also a shareholder of the FHLB of San Francisco, which enables the Bank to have access to lower cost FHLB financing when necessary. As of September 30, 2004, based on collateral pledged, the Bank had a total credit line with the FHLB of San Francisco totaling $498.4 million. The total credit outstanding with the FHLB of San Francisco at September 30, 2004, was $434.9 million. These borrowings are secured by residential mortgages and investment securities.

Liquidity can also be provided through the sale of liquid assets, which consist of federal funds sold, securities sold under agreements to repurchase, and investment securities available-for-sale. At September 30, 2004, such assets at fair value totaled $1.80 billion, with $0.81 billion pledged as collateral for borrowings and other commitments. The remaining $0.99 billion was available as additional liquidity or to be pledged as collateral for additional borrowings.

We had a significant portion of our time deposits maturing within one year or less as of September 30, 2004. Management anticipates that there may be some outflow of these deposits upon maturity due to the keen competition in the Bank's marketplace. However, based on our historical runoff experience, we expect that the outflow will be minimal and can be replenished through our normal growth in deposits. Management believes all the above-mentioned sources will provide adequate liquidity to the Bank to meet its daily operating needs.

The Bancorp obtains funding for its activities primarily through dividend income contributed by the Bank and proceeds from the issuances of securities, including proceeds from the issuance of its common stock pursuant to its Dividend Reinvestment Plan and the exercise of stock options. Dividends paid to the Bancorp by the Bank are subject to regulatory limitations. The business activities of the Bancorp consist primarily of the operation of the Bank with limited activities in other investments. Management believes the Bancorp's liquidity generated from its prevailing sources is sufficient to meet its operational needs.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

Since interest rate sensitivity analysis does not measure the timing differences in the repricing of assets and liabilities, we use a net interest income simulation model to measure the extent of the differences in the behavior of the lending and funding rates to changing interest rates, so as to project future earnings or market values under alternative interest rate scenarios. Interest rate risk arises primarily through the Company's traditional business activities of extending loans and accepting deposits. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the spread between interest earned on assets and interest paid on liabilities. The net interest income simulation model is designed to measure the volatility of net interest income and net portfolio value, defined as net present value of assets and liabilities, under immediate rising or falling interest rate scenarios in 100 basis point increments. The Company monitors its interest rate sensitivity and attempts to reduce the risk of a significant decrease in net interest income caused by a change in interest rates.

The impact of interest rate changes to our net interest income is measured using a net interest income simulation model. The various products in our balance sheet are modeled to simulate their interest income and expense, and cash flow behavior in relation to immediate and sustained changes in interest rates. Interest income and interest expense for the next 12 months are calculated for current interest rates and for immediate and sustained rate shocks. The net interest income simulation model includes various assumptions regarding the repricing relationships for each product. Many of our assets are floating rate loans, which are assumed to reprice immediately and to the same extent as the change in the forecasted market rates according to their contracted index. Our non-term deposit products reprice more slowly, usually changing less than the change in market rates and at our discretion. Our term deposits reprice based on their contractual maturity. This net interest income modeling analysis indicates the impact of change in net interest income for a given set of rate changes. In addition, the model assumes that the balance sheet does not grow and remains similar to the structure at the beginning of the simulation period. As such, the model does not account for all the factors that could impact a change to interest rates, including changes by management to mitigate the impact of interest rate changes or secondary impacts such as changes to our credit risk profile as interest rates change. Furthermore, loan and investment spread relationships change regularly, whereas the model spread relationships are kept constant. Interest rate changes create changes in actual loan and investment prepayment rates that will differ from the market estimates incorporated in the analysis. In addition, the proportion of adjustable-rate loans in our portfolio could decrease or increase in future periods if market interest rates remain at or decrease or increase from current levels. The repricing of certain categories of assets and liabilities are subject to competitive and other pressures beyond the Company's control. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and at different volumes. As a result of the above constraints, actual results will differ from simulated results.

We establish a tolerance level in our policy to define and limit interest income volatility to a change of plus or minus 30% when the hypothetical rate change is plus or minus 200 basis points. When the net interest rate simulation projects that our tolerance level will be met or exceeded, we seek corrective action after considering, among other things, market conditions, customer reaction, and the estimated impact on profitability. At September 30, 2004, if interest rates were to increase instantaneously by 100 basis points, the simulation indicated that our net interest income over the next twelve months would increase by 3.78%, and if interest rates were to increase instantaneously by 200 basis points, the simulation indicated that our net interest income over the next twelve months would increase by 7.72%. Conversely, if interest rates were to decrease instantaneously by 100 basis points, the simulation indicated that our net interest income over the next twelve months would decrease by 3.13% and if interest rates were to decrease instantaneously by 200 basis points, the simulation indicated that our net interest income over the next twelve months would decrease by 4.76%. The Company's simulation model also projects the net economic value of our portfolio of assets and liabilities. We have established a tolerance level to value the net economic value of our portfolio of assets and liabilities in our policy to a change of plus or minus 30% when the hypothetical rate change is plus or minus 200 basis points. At September 30, 2004, the Company was within such guidelines.

Financial Derivatives

It is the policy of the Company not to speculate on the future direction of interest rates. However, the Company enters into financial derivatives in order to seek mitigation of exposure to interest rate risks related to our interest-earning assets and interest-bearing liabilities. We believe that these transactions, when properly structured and managed, may provide a hedge against interest rate risk inherent in the Company's assets or liabilities and against risk in specific transactions. In such instances, the Company may protect its position through the purchase or sale of interest rate futures contracts for a specific cash or interest rate risk position. Other hedge transactions may be implemented using interest rate swaps, interest rate caps, floors, financial futures, forward rate agreements, and options on futures or bonds. Prior to considering any hedging activities, we seek to analyze the costs and benefits of the hedge in comparison to other viable alternative strategies. All hedges will require an assessment of basis risk and must be approved by the Bank's Investment Committee.

The Company recognizes all derivatives on the balance sheet at fair value. Fair value is based on dealer quotes or quoted prices from instruments with similar characteristics. The Company uses financial derivatives designated for hedging activities as cash flow hedges. For derivatives designated as cash flow hedges, changes in fair value are recognized in other comprehensive income until the hedged item is recognized in earnings. For derivatives designated as fair value hedges, changes the fair value of the derivatives will be reflected in current earnings, together with changes in the fair value of the related hedged item. reflected in current earnings, together with changes in the fair value of the related hedged item, if there is a highly effective correlation between changes in the fair value of the interest rate swaps and changes in the fair value of the underlying asset or liability that is intended to be hedged. If there is not a highly effective correlation between changes in the fair value of the interest rate swaps and the changes in the fair value of the underlying asset or liability that is intended to be hedged, then only the changes in the fair value of the interest rate swaps are reflected in the Company's financial statements.

On March 21, 2000, the Company entered into an interest rate swap agreement with a major financial institution in the notional amount of $20.0 million for a period of five years. The interest rate swap was for the purpose of hedging the cash flows from a portion of our floating rate loans against declining interest rates. The purpose of the hedge is to provide a measure of stability in the future cash receipts from such loans over the term of the swap agreement, which at September 30, 2004, had a remaining term of approximately two quarters. At September 30, 2004, the fair value of the interest rate swap was $0.5 million, exclusive of accrued interest. Amounts to be paid or received on the interest rate swap are reclassified into earnings upon the receipt of interest payments in the underlying hedged loans, including amounts totaling $0.2 million that were reclassified into earnings during the quarter ended September 30, 2004. The estimated net amount of the existing gains within accumulated other comprehensive income that are expected to reclassify into earnings within the next six months is approximately $0.4 million.

In 2004, the Company entered into interest rate swaps with notional amounts of $85.4 million for five years to mitigate risks associated with changes to the fair value of a like amount of fixed rate certificates of deposit (CDs). The five year interest rate swaps will terminate in 2009 and can be terminated after two years at the election of the counterparty. For the first two years of the swaps, the Company will receive interest at a fixed weighted average rate of 3.15% and will pay interest at a rate of LIBOR less 12.5 basis points. If the swaps are not terminated in 2006, then the Company will receive interest at a fixed rate weighted average of 6.0% and will pay interest at a rate of LIBOR less 12.5 basis points for the last three years of the swap term. The five year CDs will mature in 2009 and can be terminated after two years at the election of the Bank. For the first two years of the CDs, the Bank will pay interest of 3.03%. If it does not call the CDs, then the Bank will pay interest of 5.86% for the last three years. As of September 30, 2004, the fair value of these interest rate swaps was an unrealized gain of $342,000 and the fair value of the CDs hedged by these swaps was an unrealized loss of $317,000. These amounts have been recorded in income for the third quarter.

During the third quarter of 2004, the Company entered into $25.0 million notional amount of three year interest rate swaps maturing in 2007 which can be terminated in 2005 at the election of the counterparty. Although these swaps were entered into as a hedge against a like amount of step up CDs, there was insufficient correlation between the changes in the fair value of the interest rate swaps versus the changes in the fair value of the step up CDs to permit hedge accounting treatment. At September 30, 2004, the fair value of the $25.0 million of interest rate swaps of $38,000 was recorded as other income.

During the third quarter and the first nine months of 2004, the $110.4 million in notional amount of interest rate swaps added $341,000 and $358,000, respectively, to net interest income. The estimated net interest income expected within the next twelve months from these interest rate swaps is approximately $0.9 million.

Item 4. CONTROLS AND PROCEDURES

The Company's principal executive officer and principal financial officer have evaluated the effectiveness of the Company's "disclosure controls and procedures," as such term is defined in Rule 13(a)-15(e) of the Securities Exchange Act of 1934, as amended, (the "Exchange Act") as of the end of the period covered by this quarterly report. Based upon their evaluation, the principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

There has not been any change in our internal control over financial reporting, that occurred during the fiscal quarter covered by this report, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 1. LEGAL PROCEEDINGS

The Bancorp's wholly-owned subsidiary, Cathay Bank, has been a party to ordinary routine litigation from time to time incidental to various aspects of its operations. Management is not currently aware of any litigation that is expected to have material adverse impact on the Company's consolidated financial condition, liquidity, or the results of operations.

Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

In April 2001, the Board of Directors approved a stock repurchase program of up to $15 million of the Company's common stock. Cumulatively through September 30, 2004, the Company has repurchased 639,820 shares of the Company's common stock for $8.8 million. No shares have been repurchased since the third quarter of 2003.

Item 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS